Is the U.S. headed the way of Zimbabwe, with endless central bank monetization of the central government’s debt?
In a non-firewalled op-ed for the Financial Times, World is right to worry about US debt, which is introduced by the Op-ed editors with the sentence “America must face up to its responsibilities, writes Kenneth Rogoff”, we get some plain talk from the co-author of “This Time Is Different: Eight Centuries of Financial Folly”. That book, which was begun long before Lehman Brothers collapsed and thus was unexpectedly timely when published early in 2009, was a study of major financial collapses throughout much of modern and semi-modern times. Herewith, some excerpts:
Many foreign observers look at the US budget shenanigans with confusion and dismay, wondering how a country that seems to have it all can manage its fiscal affairs so chaotically. The root problem is not just a hugely elevated level of public debt, or a patently unsustainable trajectory for old age entitlements…
America must shortly answer a series of fundamental questions…
… if the US were ever forced to surrender the mantle of world policeman to, say, China, foreigners may no longer have quite the same desire for its debt.
Productivity improvements in government services have been glacial compared with many other sectors of the economy. A visit to a primary school classroom in many US cities is the closest thing one can get to time travel…
…there is a wide chasm between those who see union domination of infrastructure as key to ensuring high-paying jobs versus those who want infrastructure built, but at reasonable rates. There is the joke about the visiting Chinese group that asks their New York tour guide how long it will take to finish the Second Avenue subway. On being told two years, the Chinese translator hesitates before conveying the response and asks: “Wait a second, you mean two weeks, right?
Perhaps my favorite:
The idea that one should just ignore all these problems and apply crude Keynesian stimulus is a dangerous one. It matters a great deal how the government taxes and spends, not just how much.
“Crude Keynesian stimulus”? Take that, Dr. Krugman!
Finally, he gets to the Japan analogy:
The US debt level is a constraint. A growing number of empirical studies, including my own joint work with Carmen Reinhart, suggest that the US has already reached a debt level that has been associated with slower growth in advanced countries. The fact interest rates are low today does not necessarily mean the US is an exception to this rule – take one look at stagnant Japan’s rates.
Dr. Rogoff’s research has shown that historically, full recoveries from systemic financial meltdowns have taken 10 years on average. Nonetheless, he is clearly calling for significant cuts in the fiscal deficit, with whatever effects on economic activity doing so would have.
Of course, he does not set policy. But he may be in the political mainstream, which in America has tended to have its views heard sooner or later.
In response to unending fiscal can-kicking and unending Fed money-printing, the Treasury bond market is doing what it has done periodically ever since the great bond bull market began over 30 years ago, which is to begin to have a hissy-fit about overly-low Fed-imposed short-term rates. The chart on the long end is beginning to look ugly. As opposed to falling rates, which allow governments to run larger deficits and encourage central banks to “stimulate”, rising rates do the opposite. Many may recall the exchange Bill Clinton had early in his first term with his advisor Robert Rubin. This involved the president learning that the bond market could not be defied. Thus he implemented large tax increases in 1993 in good measure to be able to finance “Clintoncare”, which he pushed for soon after the tax increase was imposed. (When this effort failed, lo and behold the U.S. had fortuitously taken a big step toward a balanced budget. The taxes remained, but the healthcare spending never materialized.)
The bond market may force the Feds to shrink the fiscal deficit in order to continue to roll over trillions of dollars of existing debt while still selling lots of new debt into the marketplace. This can occur even while the Fed continues its Treasury bond-buying program, which is after all but a small player relative to the above total, of which the “roll” is much larger than the total new debt.
There are various things that cannot all exist simultaneously. One such grouping is large fiscal stimulus, large monetary stimulus, ultra-low interest rates, rising home prices, and economic growth. Something’s got to give.
The Japanese experience has been that periodically, interest rates would jump up on the long end, now and then associated with a baby step or two toward Bank of Japan tightening, and soon after economic activity would again falter. While the U.S. has greater resources than Japan, and is biased toward inflation due to its role as provider of the global reserve currency, unfortunately I am still not seeing an important deviation from this old analogy of mine. As in Japan, the demographics remain challenging. Also as in Japan, almost everyone here remembers the decades of historically high interest rates above 5%. Thus the headlines in the financial press are full of the “bursting bond bubble” trope. But a bubble cannot really exist if almost no one believes in its core story. And this low interest rate environment is broadly viewed as a gross aberration, not as a somewhat extreme version of what was for many years viewed as normal – a low cost of borrowing for high-quality borrowers.
If the U.S.-Japan financial analogy continues to be valid, the right strategy would be to buy Treasury bonds if rates continue to rise toward 1-2 year highs. While the Fed likes higher stock prices, what it is doing in the real world that we know for sure is buying Treasurys.
Not fighting the Fed means not fighting the bond bull market.
Addendum (Jan. 27): In re-reading the post, I realize I was unclear in the final sentence. Clearly, as stated in the preceding paragraph, bonds are not currently in a bull trend. I was referring to the longer-term bull market in bond prices, which has yet to give up that ghost. My point was that it’s one thing to avoid bonds now, but many people have gotten burned in the past few years by shorting them and thus have fought the Fed– usually getting singed if not burned in the process.